The Perils of Following A Hedge Fund Manager

We are all looking for that edge when investing or trading, that one little nugget of information that will over time transform our stake into that pot of gold.  Sometimes that edge is provided by following the big money flows, and when a big money manager is taking a position either short or long we often want to ride his/her coattails, especially when they are so ‘generous’ to let us know.  The notion that fund managers are much smarter than us and must have some sort of ‘information’ that says they get it right all the time.  It’s just so easy, right?

Some of the most successful hedge fund managers are winners for many reasons besides ‘information’ and many have made themselves and their clients wealthy because of their actions.  Most of us are not in a position to be in these funds but if they are talking their book in the media then it should surely be okay to follow, right?  Not necessarily.  Some may have some great information and we in the public can choose to follow – or not.  Yet, there are perils to following these managers, and recent examples of failure show us why it is better to do our own due diligence.

The latest hedge fund manager to take his place in the hot seat is well know Pershing Square Management’s Bill Ackman.  A known activist, Ackman has had some great success over the years presenting his case for/against some companies, but more recently has found himself in difficulty. Over the years, investors have followed this smart fund manager into some nice wins, so why shouldn’t that happen each time Ackman is vocal?  After all, an activist shareholder is looking out for the ‘little guy’, or so it seems.

Many are well aware of his disdain for Herbalife (NYSE: HLF) and the public battles with activist Carl Icahn and the company management.  Ackman has frequently called the company a ponzi scheme and has been short the stock for years.  That position however seems to be at a substantial loss.

Valeant Pharmaceuticals (NYSE: VRX) has caught his affection, and Ackman seems to have put his money where his mouth is.  Further, he won’t miss an opportunity to extoll the virtues of the company and how it is a great investment.  Ackman has talked openly and often about the company and his long investment in the media and seemed to have enjoyed a great run, the stock peaking in August at 260+, up well over 80% on the year.

Well, some recent negative news has hit the company and the stock has been in free fall, losing all of those gains and then some.  As of the November 6 close Valeant was at 81 a share, having lost over 70% of its value in just two short months! Apparently, Ackman has doubled down on his bet believing the troubles are going to disappear.  Yet, if you followed him into the stock you are sitting with a loss, probably a big one.  What do you do now?

Some activists are real value, like Carl Icahn, Nelson Peltz, Jim Chanos and Dan Loeb.  They often do not trust management and provide a loud voice for the small investor.  But we have to be careful – for every Netflix or Apple suggested by Icahn (both stellar), there is a Transocean (awful).    Bill Ackman has far more wins than losses over his career and has extracted more value for investors, but just blindly following him or any other investor could lead to a disastrous outcome like Valeant.  The best answer is to do your own homework and research and then use these activists as a complementary anecdote if they happen to support your position or thesis.